What follows below is a transcript of my interview earlier this morning with Senator John McCain on the investor class and the stock market. Big Mac is talking tax cuts on capital gains, businesses, and individuals. There is no question that he is energized. Politically, he is still running even with Obama among investors. That is not good. Is there time for Senator McCain to break through and run up his margin with this crucial voting block?

Larry Kudlow: Let me go back to the first question, which you were beginning to answer. We've had this terrible stock market slump. Some say $3 trillion dollars worth of wealth have been lost by investors in the investor class. And I was asking, and I think you were answering, what is your plan to create some recovery in the stock market?

Senator McCain: Keep taxes low, cut spending, create jobs with alternative energy, including nuclear power plants, including drilling offshore, wind, tide, solar. Free us from our sending $700 billion or whatever it is across to countries that don't like us very much. Free up credit. Larry, I’ve been meeting with a lot of small businesspeople, and they're having great difficulty getting lines of credit. This is something we've got to free up. Now, we have given the banking, the banks and other institutions the kind of infusion they need. It's time they pass that on to small businesses who say they can hire. They've got business, but they just haven't got the line of credit.

But make sure that everybody knows that we're going to keep taxes low. We're not going to raise taxes. We're the creator of business and the engine of our economy and small business, Senator Obama's proposal would tax half of all small business income, some 16 million jobs in America would be at risk. And then you put on top of that, he will force his mandated health care plan on small businesses, their employees, and their children. It's not good for America.

Kudlow: Just on the credit piece that you mentioned a few moments ago, have you and your campaign been following the improvement in the Libor credit market in London and the commercial credit markets here in New York? It looks like the Treasury plan is beginning to work. That may be a positive sign. Do you follow those areas?

McCain: Yeah, I do, and I get updates all the time. One of the areas that I’m still very disappointed in, though, Larry, and you may not agree with me, we've got to go in and get these home mortgages bought and give people mortgages they can afford so they can stay in their home. Look, I’m in Ohio. Homes are being foreclosed everywhere. A lot of these people, it's their primary residence, could stay in their home if they had a new mortgage at the new value of their home, at payment levels they could afford. That is the slow -- one of the slowest parts. I think it's the slowest part right now. Keep people in their homes. If they can't realize the American dream and stay in their homes, then obviously, the rest of this equation is hard to complete.

Kudlow: Let me swing back to the investor side. There are about 100 million investors, according to the Federal Reserve survey. And interestingly, in recent national elections, they're a huge voting block, almost two of every three votes cast are cast by people that own stocks either directly or indirectly. And yet, sir, you very, very seldom mention investors on the campaign trail. Why is this?

McCain: Well, I try to talk about them more often. A lot of the people that come, frankly, are people that are having trouble staying in their homes, keeping their jobs, et cetera. But I think it goes back to all this business of Senator Obama's view of "fairness." When Charlie Gibson said, why would you want to raise capital gains taxes when you know it will decrease revenue? And he said in “fairness”. And he told Joe the Plumber -- Joe the Plumber got the message through better, what we've been trying to do this whole campaign. [Obama] wants to "spread the wealth around." That takes from the investor class. That takes money from one group of Americans and gives it to another.

Now that signal has been very clear. And I think people ought to pay attention to it, because it's been tried before in other countries, and policies of other left, liberal administrations. It doesn't work, and it's bad for America. We want to encourage the investor class, and that means capital gains and dividend taxes are low.

Kudlow: You've just unveiled a new tax cut on capital gains. Can you tell us about that? Because in some sense, that's probably the most important investor class tax.

McCain: It's the most important in many respects, Larry, and we want it low and we want it lowered. Every time -- there's one tax that there's no argument about, that every time it's been lowered since Jack Kennedy, we have seen an increase in revenues. Now, why anybody would argue, as Senator Obama does, that we need to raise it, even if it's -- of course, the amount needed to raise it is varied with whatever poll he's taken, but the point is that we want to lower it and keep it low and encourage investment, especially now in America in these difficult times.

Kudlow: But Senator, what is -- the current law rate is 15%.

McCain: Yeah, yeah.

Kudlow: You're taking the cap gains rate down to what?

McCain: First down to 10%, I would like to see it, and gradually even make it lower. Look, why should we tax people's gains twice? Why should we tax them twice, okay? They make an investment, they should be able to get their returns on their investment. And capital gains is obviously -- low capital gains tax is probably the greatest incentive for investment that we have in America today. And so, look, I’ll be glad to listen to smart people like you, Larry, but the worst thing we can do is tell people we're going to raise it, and that, obviously, would chill investment in America, right?

Kudlow: Well, with your lower capital gains tax, which in a recent speech you said 7.5% for two years, are you surprised, though, that respected pollsters like Scott Rasmussen or Investors Business Daily are still showing you running neck and neck, even with Mr. Obama? Back in 2004, President Bush beat John Kerry by 11 percentage points among investors. Now, you've got a lower cap gains tax. Mr. Obama proposes to raise the cap gains tax from 15% to 20%. Except you're still running even in the polls. Can a Republican win running even among investors? And why don't you think your message on capital gains has resonated with a bigger margin among investors?

McCain: I'm not sure, except obviously, when he broke his word that he would take public financing if I also did, he signed a piece of paper, that obviously, he's had a huge money investment. Look, I’m a 7.5%, I’d like to keep it permanently at 7.5%. Right now, we need more investment in America and in the stock market and in businesses and investment than ever before in these difficult times. So, it's pretty clear that if we keep them low, we will provide another tool for encouraging investment. Look, we are -- I am so happy we are where we are. I see a level of enthusiasm out here in this campaign, Larry, that is remarkable. I haven't seen this level of enthusiasm before. I'm very optimistic, and we're coming from behind. I'm the underdog. That's where we always like to be. But we are within margin, and I’m very happy where we are.

Kudlow: Another really important tax for the stock market investors, of course, is corporate profits. Profits are the mother's milk of stocks, as I have said from time to time. You've proposed to lower that from 35% to 25%. Senator Obama says the other day, that's merely another huge and permanent tax cut for corporations, including $4 billion dollars for the big oil companies, but it is no help for workers. Would you react to Mr. Obama's criticism of your corporate tax cut?

McCain: He doesn't get it. Corporate tax rates in America are the second highest in the world. Japan is only higher. Ireland has 11%. Business -- I like to call them business taxes, because that's what they really are, because they're businesses and they create jobs and they create employment. And when businesses can go anyplace in the world, where are they going to go? Look, I can name you Fred Smith of FedEx, Meg Whitman, other CEOs who will tell you, when they have a choice to go around the world and pay less in taxes where they can invest more and increase businesses and jobs, they're going to do that. Obviously, they want to stay inAmerica. And they want to create jobs in America, and they will, but we want to give them the incentive to do so. And lowering the business tax, the corporate taxes, in my view, they should be lower than 25%. Why is it that we're the second highest in the world, when 20 or 30 years ago, we were amongst the lowest in the world? It's not an incentive to businesses and jobs in America. It shows, frankly, that Senator Obama just doesn't get it.

Kudlow: You said yesterday or the day before when you were in Miami, Florida, the Democratic Congress is going to remove tax incentives or tax preferences for 401(k) accounts. Of course, that is a huge investor issue. What did you mean by that? What is the plan that Democrats want to take away from 401(k)s?

McCain: Well, that's exactly what they're saying. And Barney Frank, who is powerful, chairman of a powerful committee in the House, said we're going to raise taxes and we're going to increase spending. That's exactly the wrong thing to do in the economic difficulties we have. How did we get into this ditch? We ran up a $10 trillion deficit on our kids and half a billion dollar debt to China. So, obviously, they want to take the 401(k)s and use that money to give that to the government to spend, rather than people, and I think that's very dangerous disincentives to savings, which is exactly the cause of one of our problems, as we all know.

Kudlow: Last one, Senator, and I appreciate your time very much. Americans have an innate sense of optimism and confidence about stocks and the economy. The Rasmussen poll shows 73% believe stocks will be much higher five years from now than they are today. Is there a way for you in the closing days of this campaign to appeal to the innate sense of optimism that Americans have? Is there a way for you to connect with the investor class?

McCain: Well, I hope we've connected with the investor class by them examining our plans as we come closer to the election. But I also have to tell you, Larry, the people who want to invest are Joe the Plumbers of this world who want to own their small business. They want to employ people, and they want to invest in their futures and in the stock market and make investments, 401(k)s, IRAs and others, so that they could ensure their retirement and their future. And Joe the Plumber was able to do something that we hadn't been able to do this whole campaign, and that is articulate the reason why he doesn't want to see his taxes raised so that he can use it to buy a business and create jobs and to take care of his and his family's future. That's what this campaign is boiling down to, and that's why we're getting closer and closer, my friend.

Kudlow: All right, Senator McCain, thank you ever so much for sharing your time. Good luck in the rest of the campaign, sir.

Thursday, October 30, 2008

Today’s GDP report showed a small contraction of 0.3 percent. But stocks went up nearly 200 points anyway. Many observers believe the third-quarter downturn was not a catastrophe, especially if you factor in hurricanes and the Boeing strike. On top of that the short-term tax rebates ran out in the third quarter, and that helped depress consumer spending, which did fall 3.1 percent.

However, inventories are quite low after three quarterly declines. And business capex shipments actually rose slightly in the three-month period ending in September. So there’s no collapse, at least yet, in business investment.

Most analysts expect a much worse drop in the fourth quarter, ranging between a 3 and 4 percent contraction. But they are not factoring in a roughly $200 billion annual drop in consumer energy expenses that will accrue from the collapse of oil and gasoline prices. This is gonna be a big consumer booster.

Meanwhile, credit markets continue to defrost and commercial paper is now rising again, as is inter-bank lending. So the economic story may not be near as bad as the consensus thinks. Remember, of course, the Fed is pumping in cash at a huge rate. That’s going to help the whole story.

The dumbest thing I heard today on the economy was a statement from Sen. Obama. He says the decline in GDP is “a direct result of the Bush administration’s trickle down, Wall Street first, Main Street last policies that John McCain has embraced for the last eight years and plans to continue for the next four.”

Wait a minute. Did I miss something here? After the bursting of the tech bubble and the 9/11 attacks, George Bush lowered tax rates across-the-board for individuals and investors. The stock market rallied uninterruptedly for five years. The economy expanded from the end of 2001 to the end of 2007. Are we to really believe the Obama narrative that cutting tax rates is the cause of this downturn? Not the credit shock? Not the Obama-supported government mandate to sell unaffordable homes to low-income people and to pressure Fannie and Freddie to securitize these loans? And not the oil shock, as well?

Click here to listen to the podcast of my interview earlier this week with Pajamas Media's Ed Driscoll. We covered a bunch of topics ranging from Treasury man Paulson's handling of the financial crisis to Obama's team of economic advisors.

While we're taking a trip down memory lane, almost four years ago in this spot, I was pointing out Mason Dixon's state polls and saying that I found them pretty reliable. Looking back, they had the right winner in every state except Minnesota.

I mention that because this morning Mason-Dixon puts Obama ahead by 4... in Pennsylvania. With 9 percent undecided.

Wednesday, October 29, 2008

John McCain is gaining traction on the tax issue as he aggressively makes the case that Obama the Redistributor will take your money and give it to someone else, while he, McCain, will create more economic opportunity by growing the pie for everyone.

Key polls — like Rasmussen, Gallup, Battleground, and IBD — show a narrowing of the race to 2 or 3 percentage points just in recent days. This is in part because Joe the Plumber has crystallized McCain’s campaign message to a pro-growth tax-cut recovery plan that reaches out to investors all across the country. Now the big question is whether McCain will stay on message and keep hammering these points home.

Two days ago in Ohio, McCain argued: “We will cut the capital-gains tax. And we will cut business taxes to help create jobs, and keep American businesses in America.” It’s the first time he referred explicitly to his capital-gains tax cut, which would take the investment rate to 7.5 percent from current law of 15 percent.

Against the backdrop of plunging stocks and deflating home prices, that means asset buyers would keep 92.5 cents of every additional dollar of profit from the purchase of underwater stocks, houses, or any other asset. Current law will let you keep 85 cents on the extra dollar. So McCain’s plan is a 9 percent incentive reward to invest and take risks.

Now contrast that with Obama’s capital-gains tax hike to a 20 percent marginal rate (at least). That means you keep 80 cents of the extra dollar of invested profit instead of today’s rate of 85 cents. In other words, that’s a 6 percent penalty compared with current law.

Adding up McCain’s 9 percent reward and Obama’s 6 percent penalty, we’re talking about a 15 percent swing in the after-tax cost of capital and reward for investment. Stocks have already fallen 40 percent from last October’s peak. So the 15 percent differential between the Obama and McCain plans makes a very big difference to the 100 million investors who comprise nearly two of every three votes in presidential elections.

Additionally, McCain would provide a $15,000 capital-loss tax deduction and would lower the tax rate on retired investors who redeem their 401(k)s or IRAs to a rock-bottom 10 percent. Plus, McCain would drop the corporate tax — a big boon to consumers who actually pay the tax — and would keep income-tax rates at present levels.

Obviously, there’s a very significant difference between the Democratic and Republican plans. If only Mac hammers this home in the final days of the election. Sure, folks have a strong dislike for redistribution. They prefer opportunity. They want to grow the pie larger. And they don’t want left-wing activist Supreme Court judges to take away even more of their economic rights. Hence McCain’s case grows even stronger — if he pounds away and makes it. But yesterday on CNBC John McCain never mentioned capital-gains or investors. That’s not the way to do it.

The latest IBD/TIPP poll shows a 46-46 toss-up among investors. That’s not good. What I’m saying here is that while the redistribution argument is working, it needs to be bolstered by a strong case to investors, who are usually the very base of the GOP.

The opportunity is there for Sen. McCain. But he must have a disciplined investor message in the remaining days.

Monday, October 27, 2008

Supply-side father Art Laffer penned a blockbuster in today’s WSJ entitled, “The Age of Prosperity Is Over.” (Art and Steve Moore have a new book out with the same title.) It compares the Bush administration and Congress with Herbert Hoover for all their bailout actions.

The money sentence: “Financial panics, if left alone, rarely cause much damage to the real economy, output, employment or production.” Art asks: If all these bailout measures are so good, then why is the stock market so bad? It reminds him of Richard Nixon or Jimmy Carter. Art also argues that huge budget deficits will increase future tax burdens on the economy and will do nothing to encourage economic growth. He says stop rewarding failure.

And let me add, in today’s news, the car companies from Detroit are looking for bailouts. Perhaps other industries, as well. Plus, the Treasury will be parking new capital into the insurance companies. Who knows? Maybe retailers will be next. By the time we’re done, perhaps oil companies, who are now suffering from $60 oil, will get bailed out, too.

I wonder if our free-market capitalist system doesn’t really need a nice big failure to reassert its bona fides. Yes, I am growing weary of all this.

Meanwhile, a new paper from the Minneapolis Fed takes issue with the credit-crunch hypothesis. Looking at Federal Reserve Board data, they note that various forms of bank loans are actually rising, not falling. Putting a pencil to their analysis, I can report this: Total loans and leases from U.S. banks are growing at a 19 percent annual rate over the last three months. Business loans are up 19 percent. Consumer loans are up 13 percent. Real estate loans, which include home-equity and commercial real estate loans, are up 15 percent at an annual rate.

The worst story is inter-bank loans. They are flat. That’s the LIBOR story, which is healing after the FDIC guaranteed bank-to-bank loans. The LIBOR rate has come way down. I think the FDIC move was the single-most important contributor to credit stability.

But when you look at all the other loan categories that are rising, and then the 20 percent growth of the basic money supply, and the tax-cut effect of plummeting energy costs, you have to wonder: Just how bad is our economic story?

Back in early 1981, when I went to Washington to work for President Reagan, one of the architects of supply-side economics, Columbia University’s Robert Mundell, visited my OMB budget-bureau office inside the White House complex. At the time we were suffering from double-digit inflation, sky-high interest rates, a long economic downturn, and a near 15-year bear market in stocks.

So I asked Prof. Mundell, who later won a Nobel Prize in economics, if President Reagan’s supply-side tax cuts would be sufficient to cure the economy. The professor answered that during periods of crisis, sometimes you have to be a supply-sider (tax rates), sometimes a monetarist (Fed money supply), and sometimes a Keynesian (federal deficits).

I’ve never forgotten that advice. Mundell was saying: Choose the best policies as put forth by the great economic philosophers without being too rigid.

Of course, John Maynard Keynes was a deficit spender during the Depression. Milton Friedman warned of printing too much or too little money. And Mundell, along with Art Laffer, Jack Kemp, and others, revived the importance of reducing high marginal tax rates to reward work, investment, and risk. The idea was to make each of these activities pay more after tax, and in the process boost asset values across-the-board. This incentive model of economic growth was used effectively by President John F. Kennedy and the great 1920s Treasury man, Andrew Mellon.

During the 1980s Reagan enacted Mundell’s three-legged approach. He slashed tax rates on the supply-side and was not afraid to run budget deficits in the Keynesian mold. At the same time, Reagan gave Paul Volcker carte blanche to practice the tough-minded monetarism that curbed excess money and vanquished inflation. This eclectic policy mix reignited economic growth, and it ushered in a three-decade prosperity boom that revived free-market capitalism.

Today, however, the economic naysayers are ignoring the advice of Prof. Mundell. Looking at our financial crisis, with its deflationary sweep from stock markets to home prices to energy, they want to lurch leftward to a big-government tax-and-spend regulatory approach. Instead, we need to put all three legs of the Mundell hypothesis in place. And we’re already two-thirds of the way there.

Treasury man Henry Paulson is using a $700 billion rescue package to prop up banks with new capital, purchase distressed assets, and backstop inter-bank lending. Keynesian deficits will finance it. But it’s working. While ankle biters on the left and right have dissed Paulson’s plan, important credit-market spreads have declined significantly in the last two weeks.

Fed head Ben Bernanke, meanwhile, is combating deflation with a Friedmanite monetarist approach — the second leg of the Mundell mix. Over the past two months the Fed has doubled its balance sheet and spurred a major increase in the basic money supply in order to meet the enormous liquidity demands that always accompany deflation. The Fed should keep this up in the coming months until stocks, commodities, and credit show life-signs of recovery.

But what’s missing is Mundell’s third policy leg: supply-side tax cuts. And here we find the partisan debate of the closing days of the presidential and congressional elections.

Democrats want to tax the rich, redistribute the wealth, and spend our way out of the economic doldrums. It won’t work. Senators Barack Obama and Harry Reid, along with Speaker Nancy Pelosi, disdain supply-side tax incentives. But Sen. John McCain wants to reemploy them as a recovery tool. McCain is right, and now is the time for the Republican party to call for sweeping tax cuts that would reduce marginal rates by half for businesses, individuals, and investors. Yes, it would be bold. But no bolder than Reagan in the 1980s, Kennedy in the 1960s, or Mellon in the 1920s.

The corporate tax rate should be slashed from 35 percent to less than 25 percent, including capital-gains. (Corporations, let’s not forget, don’t pay taxes. Only individuals do, since business costs are passed along to consumers.) The top individual rate should similarly be lowered, with fewer income brackets to clutter up the tax code. And investment taxes on capital-gains and dividends should be cut from 15 percent to 7.5 percent to revive the dormant animal spirits of investors.

These tax cuts would mean all three legs of Robert Mundell’s pragmatic approach to policy are in place. Use the money supply to combat deflation (inflation is not the problem), employ deficits to rescue and stabilize the banking and credit system, and slash tax rates to reignite economic growth.

In effect, a successful rescue plan requires a drawdown of all the major economic schools of thought. Given the current economic emergency, we need all the help we can get. For a change, how about a little pragmatism in the policy mix? That just might do the trick.

*David Kittle, Mortgage Bankers Association Chairman*CNBC’s Diana Olick will deliver a report on foreclosures here in the U.S and Hampton Pearson will offer perspective on how regulators plan to fix it.

Wednesday, October 22, 2008

It's becoming fashionable now to blame Treasury man Hank Paulson for allowing Lehman to go down and thus for precipitating the credit freeze and stock market plunge of the past month or so.

A Financial Times column today takes this logic one step further and blames Paulson's decision on Lehman for John McCain's alleged defeat. I say alleged because a bunch of polls show McCain closing — such as the AP poll and the Battleground poll, along with the latest IBD/TIPP poll. (Even while other surveys show Obama gaining.)

But back to the main point. Is Paulson to blame? I don't think so.

When I interviewed Paulson I asked him directly if his Lehman decision triggered the credit crunch. And he responded by saying that it was the British bank regulators that ruled out a Barclays' acquisition of Lehman. Therefore, there was no other place to turn.

Remember, when the Treasury and the Fed arranged a sale of Bear Stearns they had a buyer, namely JPMorgan Chase. Then the government stepped in to backstop $29 billion of bad Bear paper. But were it not for JPMorgan Chase, they couldn’t have done it. With Lehman there were no other bidders except Barclays. So what exactly was Paulson supposed to do?

Here's a second point. If the Paulson rescue plan of putting capital into banks, purchasing toxic assets, and guaranteeing short-term inter-bank loans is so bad and ineffectual, why are all the key credit spreads plunging? The three-month LIBOR dollar rate has dropped 128 basis points. The so called TED spread, which is LIBOR minus the T-bill, has declined 213 basis points. And the two-year swaps spread has dropped 56 basis points. These are key metrics that strongly suggest the money markets are defrosting and banks have resumed lending to one another.

In response, the U.S. dollar is soaring and gold is plunging. I read those two indicators as improving credit barometers. What's more, commodity prices across the board are tanking. The bubble has popped. Oil is down $5.50 today to $66.76. Retail gasoline is $2.86. These are huge consumer and corporate-profit tax cuts.

And all of this reflects the recovery mustard seeds that will after a time bloom into a new bull-market expansion. The CRB futures index has dropped from over 450 to 250. This means corporate profits, which look bad right now, are gonna look much better in the quarters ahead because commodity input costs are coming way down. And of course, the cost of food and energy will benefit consumer pocketbooks.

Today's a bad day for stocks on profit worries — which I think are overbaked. But the psychology is fearful and we'll have to live with that for a time. Nonetheless, the message of the credit markets along with the dollar supports Paulson's plan. And while the commodity plunge in the short-run may be a signal of weaker growth around the world, in the medium-term the tax-cut effect of lower raw materials will lead us to recovery.

Excesses are being wrung out of the system. That’s the nature of free-market capitalism, and it includes short-run pain. But when the dust clears, the seeds of the next business-cycle expansion will flower and bloom.

Halloween is coming up, and with it comes a great opportunity for parents to show their kids how the world really works, with the added bonus of touching on current political and economic themes. When their kids get back from trick-or-treating, parents should take 30% or so off the top as “income taxes.” (I did this last year – the reaction on my kids’ faces was priceless. I didn’t have the heart to keep it, though.) Then, parents can take another 5% or so to bail out kids who’ve already eaten their candy, and another 5% or so to “spread the wealth” to kids who didn’t go trick or treating. Then, parents can take away anything that’s left that has transfats, and some more to sell to offset the carbon produced in the candymaking. When the kids complain, the parents can tell them that they can go out and collect some more –except that since the kids are already “rich” with candy, the marginal rate on any additional candy they bring home will go up from 30% to, say, 50%.

Top tax expert Dan Mitchell sends word this morning that the second video in his tax haven series is up and running. This mini-documentary is the second installment of a three-part series on the beneficial impact of low-tax jurisdictions.

Tuesday, October 21, 2008

There’s a huge multi-thousand word article in this morning's Wall Street Journal on Paul Volcker, the former Fed chairman who conquered inflation during the Reagan years and has become a key financial advisor to Sen. Obama. Articles like this fan the flames of speculation that Volcker could be Obama’s secretary of the Treasury, despite his 81-year-old senior-citizen status. But Volcker is a vigorous 81 and I think he could handle the job.

Of course, Volcker has a great reputation as a deficit-cutter and a strong-dollar man. What’s more, as a long time financial advisor who was president of the New York Fed, undersecretary of the Treasury, and of course Fed chairman, Volcker’s money knowledge would gain bipartisan support to solve the financial crisis, which will surely spill over into next year. Volcker would attract bipartisan support because of his superb reputation. He is not a supply-sider, nor did he agree with the Reagan tax cuts in the 1980s while he was Fed chairman. But he did work well with the Gipper. Reagan’s supply-side tax cuts along with Volcker’s tight money to slay inflation produced a strong economic recovery and proved all naysayers wrong.

Volcker will unfortunately agree with Obama that the top tax rate can be raised. Not good. But he’s very good on tighter spending and King Dollar. And he does have vast knowledge of the intricacies of world credit markets.

I’m sure the Obama campaign is encouraging the Volcker speculation, since Mr. Volcker brings gravitas and experience to Obama.

The other likely candidate for Treasury under an Obama administration is Lawrence Summers, the proven protégé who was Treasury secretary during Clinton’s last year and before that undersecretary. Summers also would be a strong player, with wide knowledge of our financial problems. He’s also for a stable dollar. And noteworthy is his long-held criticism of Fannie and Freddie. Like Volcker, Summers would agree to lifting the top tax rate; he is no supply-sider. But also like Volcker, he is a moderate-to-conservative Democrat who would be well received by Wall Street and investors.

The Washington Postreports today that Sen. John McCain is out there on the campaign trail criticizing President Bush in order to deal with the Obama media attack linking Big Mac to W. Apparently McCain is criticizing Bush and Paulson as bailing out the banks rather than buying up underwater mortgages to help homeowners avoid foreclosure.

Okay, fine. I think Paulson’s three-cornered plan to recapitalize banks, buy up toxic assets, and guarantee short-term inter-bank loans in London and New York is the right policy. And since surfacing two weeks ago, the rescue plan is actually helping boost the stock market. But if McCain wants to go there on mortgages, then go there.

However, the senator could distance himself from President Bush in other ways that might resonate with the investor class — the important voting bloc that McCain needs to win by 10 points but is now running even.

For example, until very recently the Bush dollar kept sinking. So why doesn’t McCain distance himself from Bush by supporting a King Dollar that will attract global investment for job creation, hold down inflation, and improve America’s standing around the world? Sen. McCain also could tout across-the-board pro-growth tax reform, such as Paul Ryan’s idea of 10 percent and 25 percent marginal tax rates.

Economic emergencies require strong medicine, and tax reform along with currency reform is consistent with McCain’s message that he will be a real Washington reformer. There’s also McCain’s plan to reform the corporate tax. In this case, McCain’s rate-slashing idea can be sold as a jobs and wages booster and as a tax-cut for ordinary consumers who pay most of the higher corporate tax that is passed along to them.

These would be very strong economic-recovery ideas that are separate and apart from the Bush policies and have a strong reform message.

For those like myself who believe the stock market is on the rebound, please go to Calafia Beach Pundit, a blog site run by the very smart free-market supply-sider Scott Grannis. He has a blockbuster chart suggesting a huge rally in stocks. It’s based on the fact that the two-year swaps spread in the bond market has fallen significantly and is closely related to stocks. His chart suggests the S&P 500 could rebound to 1,200. That would be roughly 20 percent above today’s level.

Monday, October 20, 2008

It’s possible that John McCain can leverage Joe the Plumber into a tighter race in the last two weeks of the campaign.

Yesterday on Fox News McCain hammered Obama on taxing the rich and spreading the wealth by calling him a left-liberal socialist. After all, McCain argued, redistribution is a key tenet of socialism. And for the first time I heard McCain talk about a plan for economic recovery. He also talked about making the economic pie larger, rather than redistributing the existing slices, and he said he wanted to show voters how to get the economy out of the ditch by keeping taxes low.

This is all very good. McCain is now making taxes and economic recovery the centerpiece of his campaign message. And if Joe the Plumber stimulated this from Big Mac, all the better.

Of course, the plumber can’t win it for McCain. It’s up the senator to make the sale. But by refocusing on taxes and economic recovery McCain is really for the first time connecting to the front-page headlines of economic angst and financial freeze. Those are the top issues of this election.

Regrettably, McCain is not reaching out directly to investors by talking about his 7.5 percent capital-gains tax cut and his $15,000 capital-loss tax deduction. Nor is he arguing that his corporate tax cut is really a consumer — and therefore a middle-class — tax cut, since businesses pass the tax costs along in the form of higher prices.

But if Sen. McCain can get the capital-gains tax cut into his message, and if he can repackage the corporate tax cut as a Main Street tax benefit, he would stand a much better chance of getting his margins up with the heavy-voting investor class.

The just-released IBD/TIPP poll shows McCain has retaken the lead among investors with a small margin of 45-43 over Obama. Yesterday Obama was plus-2 among investors, and the day before he was plus-6. So something positive may be going on here for McCain.

Remember, Bush won investors by 11 points in 2004. And no Republican can win the presidency without a big investor vote margin. However, McCain is trailing Obama among married women, 46-42. He should be ahead by 10. And he’s only getting 65 percent of the conservative vote, whereas he should be getting 75 or more. Overall, IBD/TIPP has Obama plus 5.3, almost identical to the RealClear poll average of 5.2 percent. Rasmussen shows Obama at plus-4; Zogby has him plus-6; and Gallup has him plus-5.

So my advice to Sen. McCain is to start talking capital-gains tax cut to 7.5 percent. It’s a winner with the stock market sagging badly. Stocks will come back — in fact there’s a mini rally cooking right now. And a low cap-gains tax is a great incentive for investor-class wealth creation. Obama is going to penalize investors. But McCain will reward them.

If I had Joe the Plumber’s phone number — since he is the most influential McCain advisor — I’d tell Joe to talk cap-gains, too.

Friday, October 17, 2008

Fear and volatility continue to dominate stock markets as the economy sinks into recession and profits estimates suffer from deeper downgrades. But how bearish should investors really be?

Warren Buffett writes in today’s New York Times that now’s the time to buy. He writes, “Be fearful when others are greedy, and be greedy when others are fearful.” He advises investors to get out of cash and get into equities. He then argues, “Bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.”

While Buffett is betting on America in the long-run, there even are two short-run positives amidst the credit crisis.

One is that the Fed is finally pouring new cash into the economy. Over the last five weeks it has jammed in nearly $900 billion of fresh liquidity, doubling the size of its balance sheet. So after being flat for more than 18 months, the Fed’s reserve-bank credit is now growing at a 24 percent annual rate.

One economist who supports the central bank’s money creation is Art Laffer. He argues that falling interest rates amidst the credit squeeze has created a huge appetite for cash. And he is pleased the Fed is supplying enough new money to accommodate that appetite.

Incidentally, while the Fed is cranking up the money supply, the dollar continues to rise and the bond-market inflation spread continues to fall.

The second positive is the collapse of oil prices and the end to the energy bubble. A lot of this is from the U.S. recession. But a lot of it is simply the bursting of a speculative bubble as hedge funds and others keep selling into a declining market. It was bound to happen.

But the really good news is that the energy plunge is a huge tax cut for consumers and businesses. In the past three months retail gas prices at the pump nationwide have dropped about 25 percent, to $3.04 from $4.11. The futures market suggests another 25 cent decline is on the way. All this while the world oil price in dollars has collapsed to near $70 a barrel from nearly $150.

Mark Perry of the Carpe Diem blog estimates annual consumer savings of $188 billion from the fall in gas prices over the past three months. But that’s not all. There’s also a pronounced drop in the price of home heating fuel, natural gas, and many distillates that will provide business and consumer savings. Additionally, corporate profits will improve as a result of the steep decline of energy costs. All of this dwarfs the big-spending stimulus plans being cooked up by the Democratic congressional majority.

I think of the Fed cash injections and the energy tax cut as planting mustard seeds that will bloom into a future bull-market recovery. The mustard seed, of course, is a New Testament reference. My friend Jerry Bowyer fleshes it out: “The kingdom of Heaven is like a grain of mustard seed, which a man took, and sowed in his field: Which indeed is the least of all seeds: but when it is grown, it is the greatest among herbs, and becomes a tree, so that the birds of the air come and lodge in the branches of it.” That’s from Matthew 13:31:32.

I sat down Wednesday night with Treasury Secretary Hank Paulson in an exclusive interview for CNBC’s Kudlow & Company. The full transcript follows:

Larry Kudlow: A very special evening here. The man in the eye of the financial storm. Treasury Secretary Henry Paulson joins me live here in our nation’s capital. Thank you very much for coming back.

It’s a tough day. You know all about that. The market is down over 700 points. Your announcement was yesterday, but we still have the bumpy markets. Fear seems to rule. Volatility seems to rule. A lack of confidence everywhere. Let me ask you, sir. Are markets missing something with respect to your new plan? How do you comment on this, because it just doesn’t seem like there is a wave of confidence.

Hank Paulson: Well, Larry, there’s a lot going on right now and a lot going on in the markets. We knew that the financial markets and all the turmoil in the financial markets were going to have a significant impact on the real economy.

Today there was some evidence of that. The retail sales numbers came in at a disappointing level, but not a surprising level. So, I think what the markets are saying today is that they understand that we are going to have a difficult few months ahead of us. But what I would say is let us remember that we have a very resilient economy. Last quarter we grew at 2.8 percent.

The steps we’ve taken are absolutely the right steps. They are bold steps. They are strong steps to stabilize the financial markets and inject confidence into the banking system along with capital. When banks start lending to each other, feel comfortable dealing with each other, they will start lending to businesses and we’ll see this make a big difference in the economy.

Kudlow: Do we have to take a recession? Are we in a recession right now, sir?

This following quote will surely make David "Axis of Evil" Frum shake his head in disbelief. "When it comes to the conservative base and economics," a White House political adviser told me recently, "the only two things that matter are the [Wall Street] Journal's editorial page and Larry Kudlow."

Frum, a conservative pundit and former Bush speechwriter, has leveled some pretty biting criticism at Kudlow (and like-thinking economic conservatives), without mentioning him by name. In a recent piece of commentary that basically adopts Barack Obama's stagnant-wages-and-rising-income-inequality critique of Bushonomics, Frum writes the following: "Even before the Wall Street crisis, the American economy had underperformed from the point of view of the average worker. While national output rose strongly, most of the gains went to the top five percent of households. Most Republicans have been unprepared to even acknowledge these facts, much less explain them. They insisted that the Bush economy was 'the greatest story never told.'""The greatest story never told." It's a fun catchphrase that I've heard Kudlow repeat on his CNBC show time and time again during 2006 and 2007. (Full disclosure: I am a frequent guest on Kudlow & Co. and a CNBC contributor.) Indeed, if you do a Google search on "greatest story never told" and "Bush economy," the first thing that comes up is an article written by Kudlow for National Review Online. If you attack that idea, it's clearly an attack on the expertise of America's leading conservative economic commentator.

It's also an attack on supply-side economics and the tax cuts of 2001 and 2003....

It certainly wasn’t the big-bang across-the-board tax-reform and tax-cut plan that I and others lobbied for. But John McCain’s “Pension and Family Security Plan” unveiled today on the campaign trail does have some solid pro-growth nuggets. I’m calling it some good little stuff.

The most important pro-growth measure is a reduction in the capital-gains tax rate to 7.5 percent in 2009 and 2010. Although I wish it were permanent, at least it will reward investors who scoop up undervalued assets, including bargain-basement stocks and underwater homes. Two years is not a very wide window. But this could promote a faster recovery in asset prices and wealth creation.

Alongside the cap-gains cut, McCain is proposing to increase the amount of capital losses eligible for tax write-offs from $3,000 to $15,000 for tax years 2008 and 2009. It’s an offset to ordinary income. And again, while it should be permanent, at least it will be helpful.

Also in his plan, withdrawals from tax-preferred retirement accounts will be taxed at the lowest rate (10 percent) for the first $50,000 withdrawn from these accounts. Tax rules forcing seniors to sell retirement-account stock holdings when they reach age 70.5 will be suspended. That’s good.

In effect, going into the final debate, McCain has a significant corporate tax cut and a modest capital-gains tax cut. He also wants to keep the Bush income-tax cuts in place. All of these measures are pro-growth.

I would have preferred a Paul Ryan modified flat tax with two brackets of 10 and 25 percent. In other words, a true across-the-board reduction in marginal tax rates as an economic recovery measure to connect with folks who are worried about recessionary losses for their jobs and home mortgages. Economic anxieties are big, and a big-bang tax-cut response would be optimal.

But cutting taxes for businesses, capital gains, and individuals does give McCain a lot of pro-growth meat on the bone for the big debate.

Now, if only McCain can succeed in selling these measures. Especially the corporate tax cut, which should be sold as a middle-class consumer tax cut inasmuch as corporations pass along their tax costs to consumers in the form of higher prices. This is the key to selling the corporate tax cut. McCain’s senior advisors tell me he has been briefed on this language, but so far it hasn’t materialized in the debates. Perhaps it will Wednesday night.

Really, the McCain tax contrast with Obama is not hard to make. In the last debate McCain referred to Obama’s tax hikes as Herbert Hoover. I’d like to see Hoover reemerge tomorrow night.

Monday, October 13, 2008

CNBCSPECIAL: Please join us this evening at 7pm ET for a special edition of "Is Your Money Safe?"

Our stable of CNBC reporters, stock market, and economic all-stars will discuss and debate all the latest news and developments affecting the markets and the economy during this tumultuous time.

Topics tonight will include where to invest your money, the latest news on the rescue plan, global inter-bank guarantees, and of course, Wall Street's best day in 75 years following the street's worst week in its history.

Stocks are up over 600 points today, a record-breaking one-day rally. Good news is coming from the four corners of the world as the U.S., G-7, and G-20 are all working to stem the global banking crisis and credit freeze-up.

Most importantly, the Europeans and the Brits got out in front of the curve with a blanket guarantee for inter-bank lending. This in my view is the single-biggest solution for the credit-crunch problem. If banks won’t lend to each other, and they wont even make short-term loans to healthy businesses, then no one else is gonna get any credit — right down the line to the smallest Main Street store.

Now we are waiting for Paulson & Co. to make a similar guarantee of inter-bank loans for American banks. They are looking at it carefully, and I think the British and European actions are basically forcing the U.S. Treasury to move. Additionally, the Treasury is putting the final touches on their bank-recapitalization plan as well as their toxic-asset purchase plan. A big-bang Treasury announcement is now expected for tomorrow morning. Hopefully it will have plenty of meat on the bones.

Clearly, world stock markets are signaling strong approval of these government actions. The sooner credit starts flowing the shorter the recession is going to be. We have suffered what amounts to a credit-freeze spasm. But that spasm has spilled over into the economy. If credit starts flowing again, it is possible — amidst all the doom and gloom — that the economy could start rising a lot faster than almost anybody thinks.

The Fed is pumping in plenty of new cash. That’s a huge positive. And $80 a barrel oil, along with $3 a gallon retail gas at the pump, is a tax cut for the economy. In fact, as Democrats line up their latest package of spending and political-giveaway goodies — called a second stimulus plan — they don’t understand that plunging energy prices are the best stimulus plan of all.

Meanwhile, instead of temporary tax rebates all over again — after the first package did nothing earlier this year — John McCain should be yelling at the top of his lungs for permanently lower tax rates across-the-board. Let people keep their own money instead of hanging on the dole from government.

The highly accurate IBD/TIPP poll has started today with its daily tracking of likely voters. Just off the press: Obama 45; McCain 43; and 13 percent unsure. The poll of 825 likely voters has an error margin of +/- 3.5 percentage points. Also, McCain has a 48-41 lead among investors with 10 percent not sure. All this is good news for McCain.

An old friend of mine, Scott Grannis, emailed me earlier with some interesting insight on last Friday's successful settlement of $400 billion worth of Lehman credit default swaps. Scott is a wise veteran of the markets and the former chief economist at Western Asset Management.

It's definitely worth a read.

Best news of last week: the unregulated free market did not collapse

It's an arcane topic and that's probably why you haven't heard much about it, but the settlement of $400 billion of credit default swaps on Lehman bonds that occurred a few hours prior to Friday's market close was a major positive event....For the past two weeks the market had feared the results of an auction that was to be held last Friday to determine the settlement price of credit default swaps on Lehman bonds, an event that was triggered by the government's earlier takeover of Lehman. Some $400 billion in CDS contracts were at stake. No one really knew who was going to end up owing how much money to whom. Major dealers might end up on the hook for hundreds of billions if their counterparties failed....In the end, it was almost a nonevent. In the greatest story of this crisis not yet told, the private market mechanism set up to handle the settlement of the swaps worked perfectly....Click here to continue reading.

Fear and panic have taken over the stock market, the banking system, and the economy. It is one of those moments in history when people feel helpless, frustrated, and bewildered about what’s going on and why it’s happening.

Stocks are being pummeled in ways we haven’t seen in nearly a century, both here and overseas. The Dow Jones is down nearly 20 percent this week, its second worst week since December 1914. The S&P 500 dropped over 20 percent in what looks to be the worst week in the history of that index (going back to 1928).

Behind all this, the credit system is completely frozen. Banks are now loathe even to lend to each other in the overnight markets that are so vital to the daily financing of American business. And the profits outlook is deteriorating badly, sparking fears that we may have a deep and prolonged recession.

And yet, much good may ultimately come of this terrifying correction.

I commend everyone to read the Wall Street Journal op-ed of Friday written by John Steele Gordon, an eminent financial historian. Gordon writes that there have been financial panics roughly every twenty years throughout American history. He goes all the way back to Hamilton, who orchestrated the first banking bailout in 1792. From this came a regular money-supply system, a credible U.S. government debt system, and something of a disciplined banking system.

Gordon hopes that out of the current crisis we get a better system of well-capitalized banks regulated by a more unified government supervisory apparatus. My view is that the panic will pass and long-run American prosperity will continue. This may seem Pollyannaish right now, but I have great confidence that our free-market economy will come out better, with a strong financial underpinning, when the storm finally ends.

Paradoxical as it may be, strong government actions to stabilize banking are necessary to preserve the free-market-economy system. No free-market economy can survive without stable banking and credit. Without readily available credit, entrepreneurs can’t put their new ideas into commercial practice. And without that vital innovation, economic growth suffers.

The trick now is to use government levers in smart and efficient ways. Banks need to be recapitalized without punishing current and future shareholders. Henry Paulson is working on this. More than likely, the Treasury man and the G-7 finance ministers are figuring out a plan that will temporarily guarantee all short-term interbank lending in the New York and London money markets.

Britain has done this for its High Street banks. But the American and European banks in London are not guaranteed. This is the message of the LIBOR market, which has seized up. As of Friday, the three-month LIBOR dollar rate and its spread against Treasury bills have again increased significantly. This, in turn, is dragging down stocks.

In New York, the market for commercial paper issued by banks also has faltered. In fact, financial commercial paper has dropped nearly $160 billion in recent weeks. That’s why the authorities have to step in with a short-term backstop. Other measures to relieve banks of their distressed assets, backstop money-market funds, and guarantee all banking deposits will have a positive effect over time, as Paul Volcker noted in the Journal this week.

Meanwhile, the Federal Reserve has essentially moved off its fed funds rate target and is instead focused on injecting huge quantities of new cash into the banking system. The most basic money supply controlled by the Fed is now growing at a 16 percent rate after being nearly flat for 18 months. In the last five weeks the Fed has injected nearly $700 billion through a variety of lending facilities. This is important. The demand for liquidity during this period of asset and credit deflation cries out for massive new cash supplies from the central bank.

Then there’s oil, which is almost forgotten in this panic. The $150 oil shock and elevated prices at the pump are what worsened the credit crunch and hastened the recession. But now oil is about $80 a barrel. When the dust finally clears, lower energy prices will be an important tax-cut, pro-recovery factor. Meanwhile, the exchange value of the U.S. dollar is up 16 percent in recent months. That’s an anti-inflationary sign of confidence.

And as John Steele Gordon writes, hopefully we have learned to stop forcing banks to give mortgages to un-creditworthy customers, and to stop encouraging Fannie and Freddie to package these bad loans.

I recall the despair that surrounded the S&L/junk-bond credit crunch twenty years ago. Nobody believed prosperity would return for a long time. Commentators on the left wrote about the decline of the U.S. economy and American power. Yet the 1990s witnessed a strong prosperity boom; the free-market model of capitalism triumphed and the socialist model in Russia and elsewhere collapsed.

Yes, the months ahead are going to be tough. But I remain optimistic that our free democracy and free-market economy will survive this crisis as well.

Thursday, October 09, 2008

Please join us this evening at 7pm ET on CNBC. Our panel of stock market veterans, CNBC reporters and Washington to Wall Street experts will sort through the stock market sell-off, credit crisis and much more during this difficult time.

CNBC reporters tonight include Bob Pisani from the NYSE; Bertha Coombs from the Nasdaq; Rick Santelli from the CME; Hampton Pearson from White House ahead of the G7 meeting; Margaret Brennan on consumers and retail; and Matt Nesto on what a difference a year can make.

Wednesday, October 08, 2008

While the presidential candidates were debating in Nashville on Tuesday night the Asian stock markets were selling off by 10 percent. Earlier in the day the U.S. market plunged by 500 points. These were big-time drops, yet presidential debaters never talk about the stock market. Nashville was no exception.

Roughly $2 trillion in U.S. shareholder capital has been lost in the past 15 months. Stocks are down 20 percent over the last month alone. Those are nasty hits. Stock market people are very unhappy campers right now. And the bad-news financial statements for September are now either in the mail or on the kitchen table. But there were no references to investors either by McCain or Obama on Tuesday night. This is nuts.

The investor class is a huge voting bloc. Shareholders in recent national elections represented nearly two out of every three votes cast. And most surveys put the investor-class population at slightly over 100 million. This includes direct investment through brokerage accounts, although the vast majority of investor-class members own IRAs, 401(k)s, and defined-benefit plans, such as state and city pension funds.

So why aren’t the presidential contenders trying to connect to investors? More glaringly, why isn’t McCain?

After the debate I checked in with TechnoMetrica’s Raghavan Mayur, who puts out the respected IBD/TIPP poll. Mayur consistently ranks among the top pollsters in terms of accuracy, including his work on investor preferences. For September, Mayur’s data show McCain with a small 45-41 lead over Obama among investors. That’s roughly within the poll’s margin of error, and for McCain it isn’t enough.

Four years ago this September, George W. Bush had a 10-point lead over John Kerry among investors. In November Bush won investors by a 53-42 margin. By this measure, McCain is now way behind. And I suspect it may be a function of his reluctance to talk directly about investor taxes — especially on capital gains and dividends.

The Bush tax cuts in this area were very popular among shareholders since they reduced the cost of capital and raised after-tax investment returns. Of course, McCain has pledged to maintain President Bush’s investor tax cuts at the current 15 percent rate, while Obama proposes to raise them to at least 20 percent. But McCain seldom talks specifically about cap-gains and dividends, and the polling numbers strongly suggest he’s not connecting with investors.

Obama constantly bashes businesses and successful high-end earners, and one would think investors would be totally turned off by this. But Mayer’s polls don’t confirm it. Why? Perhaps investors sense a lack of tax-cutting passion from Sen. McCain.

For example, during the debate, McCain did mention how he and Obama differ on tax policy. At one point McCain even compared Obama to Hoover. “My friends,” he said, “the last president to raise taxes during tough economic times was Herbert Hoover, and he practiced protectionism as well.” McCain later said, “I’ve got some news, Sen. Obama — the news is bad. So let’s not raise anybody’s taxes.”

But McCain never got specific on capital-gains and dividends, and he failed to educate voters on just how important investment is to healthy job-creating businesses.

Ditto for McCain’s proposed corporate tax cut. The senator wants to slash the business tax rate from 35 to 25 percent. It’s an excellent plan. But McCain doesn’t explain how two-thirds of the benefits of a corporate tax cut go to the workforce through higher wages, with the rest then going to shareholders. He also doesn’t point out that ordinary folks actually pay the corporate tax, since firms pass this tax cost along in the form of higher prices. So McCain could, in fact, call a corporate tax cut a consumer tax cut. But he’s not doing this.

McCain also needs to put investors on red alert about Obama’s middle-class tax cut. The Illinois senator’s huge government-spending plans will overwhelm his ability to cut taxes for 95 percent of the people. In fact, McCain needs to remind voters that Bill Clinton made exactly the same promise as a candidate in 1992 before he broke it as president in 1993.

Time’s running out. The investor class vote — which still looks up for grabs — has simply got to be a McCain priority if he is to win in November. Rag Mayur doesn’t have his October polling results in yet, but he believes the race will be much tighter than mainstream pundits believe. Message to Sen. McCain: The investor vote could well tip the balance.

Fear is the big factor. Fear over the latest credit-crunch freeze-up in short-term lending markets. Fear over deepening recession. Fear over profits. Fear that Treasury-Fed bailouts — which grow larger by the minute — somehow won’t be enough. And fear that John McCain is going down in a three-house, Reid-Pelosi-Obama sweep that will raise taxes, embrace trade protectionism, end union secret ballots, and spend us into oblivion.

Amidst all this pessimism, permit me three silver linings: First, the strong dollar. Second, plunging energy prices that will generate an economy-wide tax-cut effect. And third, rapid money-supply growth after 18 months of flat money. In fact, on this last point — which is so important — it looks like the Fed has un-pegged its fed funds target rate and is instead focused on pouring cash into the liquidity-starved global banking system. Meanwhile, the Treasury purchase plan for toxic assets will get off the ground sooner, not later. And the Fed is now backstopping the commercial paper market.

Against the rising tide of pessimism I would argue that these positives are planting the mustard seeds that will grow into the next bull-market prosperity. Believe it or not.

Now it is up to John McCain to make a pro-growth case in tonight’s debate. As one friend put it at lunch, the former Navy pilot must shoot to kill. This is his last dogfight. He must hunt, not be hunted.

Today’s Zogby and CBS polls have Big Mac down only three points — a bit of encouragement from a whole spate of much worse polling numbers.

Monday, October 06, 2008

John McCain needs a knock-out performance at Tuesday night’s presidential debate if he is to keep his hopes alive.

Right now polls paint a dismal picture for Sen. McCain. Rasmussen shows Obama leading 52-44, Obama’s highest level ever. (Moving above 50 percent is a key indicator.) The RealClearPolitics average has Obama up 6 points. InTrade shows Obama up by 34 points. It also could be that key states like Ohio and Florida are now up for grabs, while Obama could win in swing states like Virginia and North Carolina. McCain, of course, is moving out of Michigan.

The financial crisis and economic downturn clearly have buried Sen. McCain in recent weeks. Some of McCain’s supporters think he can turn the page on the economy Tuesday night and instead attack Obama on character and qualifications. That doesn’t seem realistic.

The recession economy and the financial crunch are front and center. Folks are asking: Can I get a loan? Will I have a job? Can I keep my house? Unfortunately, Sen. McCain’s message overemphasizes government spending cuts, almost to the exclusion of stimulative and expansive tax cuts. This just doesn’t seem like the right time for a government spending freeze, at least to the exclusion of other pro-growth policy levers. Sounds like too much root canal. More like Bob Dole than Ronald Reagan.

That’s why McCain needs to stress that tax hikes of any kind would be a total disaster during this economic emergency, and that letting folks keep more of what they earn is a recovery prescription. He needs to emphasize the need for across-the-board tax cuts for individuals and businesses. Lower marginal tax rates will reward work, investment, and risk-taking. They also will put money in people’s pockets as they keep more of what they earn.

McCain can point to Paul Ryan’s modified flat tax with two brackets of 15 and 25 percent. That would be a great message. This is an economic emergency and it calls for strong medicine. This is not the time to take away tax cuts. It’s a time to add them. And reducing marginal tax rates would add substantially to taxpayer benefits on a permanent basis with new incentive rewards.

McCain should next talk about a corporate tax cut from 35 to 25 percent as a means of boosting jobs and wages. He should note that study after study shows that roughly two-thirds of the benefit of a corporate tax cut goes to the workforce. A corporate tax cut also is pro-investment and will make this country more competitive. But the key point is that a lower corporate tax rate is a job-creator. McCain must explain that you can’t have jobs without healthy businesses that are funded by investment.

McCain also should state that the Federal Reserve needs to keep expanding the money supply. Milton Friedman taught us many years ago that the monetary contraction of 1929-32 was a key cause of the Great Depression. So Big Mac should tell Ben Bernanke to stop targeting the federal funds rate and pump up the money supply even more. Right now credit deflation and recession are the problems — not inflation.

From the beginning of 2007 to the middle of 2008 the monetary base controlled by the Fed has grown only 1.6 percent at an annual rate. The basic M1 money supply has been flat. This amounts to a long-run liquidity squeeze. The credit-crunched economy desperately needs cash. But the Fed is not providing it.

Over the past three months the central bank has stepped up a bit to a 4 to 5 percent growth rate. But that is still way too little in today’s confidence-lacking banking environment. Everyone is hoarding cash rather than putting it to work. McCain should highlight this point.

He also should address all the Americans who might be worried about their bank accounts. He should propose that all deposits be guaranteed by the FDIC, at least temporarily. He might also suggest that G-7 central banks guarantee all inter-bank loans for regulated banks. (Hat tip to Wall Street economist John Ryding.)

Right now, McCain sounds austere when he addresses the economy. Tuesday night he must sound expansionary for economic recovery. Tax cuts, free trade, and money growth — those are the pillars of recovery. An across-the-board tax cut for individuals and businesses will boost jobs at home and our competitiveness worldwide. Free trade benefits both consumers and businesses. The Fed’s money supply must keep expanding.

Friday, October 03, 2008

Please join us for another special edition of "Is Your Money Safe?" this evening at 7pm ET on CNBC.

Our stable of CNBC ace reporters and Washington to Wall Street pros will discuss and debate all the latest news, issues, and developments affecting the markets and the economy following the passage earlier today of the Treasury rescue plan.

On the morning after Senate passage of the Treasury rescue bill stocks are down 200 points. So there is no silver bullet to our economic woes.

Now, the dollar is up strong, and gold is off $35. Those are positive signs that the Treasury bailout will improve the quality of U.S. credit. More and more over the past year, I have come to believe that gold and the greenback are more closely correlated with our credit problems than with inflation fears.

And turning back to the rescue package, tomorrow’s House vote is likely to be close, but there are a lot of positive signs that enough Republicans and Democrats will move from the nay column to a yea vote. I think the odds favor passage in the House. And the Treasury will probably start its auctions to purchase toxic bank assets in a couple of weeks. This will add much needed liquidity to the financial system.

But there is another problem: We are almost surely in a recession. Some of the recent numbers suggest the economy may have fallen off a cliff in September.

The ISM manufacturing report took a nosedive. Car sales were particularly dismal — worst in twenty years — both for Detroit and foreign auto makers. Jobless claims look recessionary and tomorrow’s nonfarm payrolls report could be down 100,000, according to the Wall Street consensus. Consumer spending for the first two months of the third quarter was 2.7 percent below the second quarter at an annual rate. The August report for business capex went negative. Non-financial corporate profits after tax are down close to 30 percent since their peak in late 2006. Profits are the mother’s milk of stocks and business. So it’s no surprise that the current bear market in shares is off nearly 30 percent since the cycle peak last October.

There are two broad reasons for the economic slump. One is, of course, the credit crunch, which seems to be biting hard. A recent survey by the National Small Business Association reported that 67 percent of small businesses said in August that they had been badly affected by the crunch. The number of small business using bank loans was at a fifteen-year low, and 32 percent said their loan terms were getting worse. The same with credit-card rates, according to 63 percent.

Let me add another cause of the recession: the oil shock, which began late last fall, and has deepened the credit crunch by draining cash from family and business budgets. Oil is trading around $94, which is a lot better than $150. But average gas prices at the pump nationwide are still around $3.65. And I don’t think that story gets any better until prices drop toward $3.

I have felt that we’ve been in a mild jobs recession this year. But surging exports, strong farm and energy sectors, and an almost unbelievable 3 percent productivity trend may have been keeping us out of a full recession. And now it looks like the cycle is truly descending. And I think the recession fear is driving down stocks today, just as I think it helped stoke Monday’s plunge. In other words, there’s more here than just the bailout package.

I sure hope Sarah Palin talks at some length about drilling in tonight’s debate with Sen. Joe Biden. Palin is an energy expert. And if she is unleashed she can score major points against her opponent, who has opposed every expansion of oil, gas, and nuclear down through the years.

Does anybody doubt that our over-regulated energy sector and high energy prices are linked? Can there be any doubt that recessionary times are in large part a function of our terrible energy policies? Even the tax-extenders in the Senate bailout bill voted on last night include a $40 billion tax increase on oil and gas companies. Nobody talked about it. I can hardly believe it. Could there be anything dumber? Tax energy more and you’ll get less of it. Huh? Is this what we need? Whatever happened to drill, drill, drill?

And here’s one: A new Rasmussen poll shows that Americans favor across-the-board tax cuts just as much as the financial rescue plan. Lower marginal tax rates should be put on the table as an antidote to the economic slump. Revive the animal spirits. Strengthen incentives to work, invest, and take new risks.

So the McCain-Palin ticket should be emphasizing across-the-board tax cuts. Sometimes Big Mac refers to congressman Paul Ryan’s idea of a modified flat tax with two low rates of 10 and 25 percent. That plus slashing the corporate tax would be a great economic recovery program, especially if combined with drill, drill, drill and King Dollar.

Gov. Palin has a great opportunity tonight to slam Sen. Biden on all these points. Even on spending cuts and the elimination of pork-barrel earmarks. Didn’t both Obama and Biden vote for the farm bill -- a $300 billion package of pork -- during a period when the farm sector was absolutely booming from high commodity prices?

McCain didn’t mention this in his debate with Obama last Friday, but I sure hope Sarah goes there tonight. Isn’t the Obama-Biden ticket really too liberal for America? Aren’t they tax-and-spenders? Aren’t they totally beholden to the enviromaniacs? Isn’t Sarah Palin the exactly right person to make this case?

Sure, we’re in a recession and a credit crunch and an oil shock. But there is a way out. Pro-growth policies in all these areas will do the trick just as they have in past slumps. Bush cut taxes during the recession at the beginning of this decade. So did Reagan almost thirty years ago. So did Kennedy almost fifty years ago. There’s a great opening for Gov. Palin. Let us hope she seizes it tonight.

About Me

Larry Kudlow

Lawrence Kudlow is CNBC’s Senior Contributor. For many years, he was the host of CNBC’s “The Kudlow Report”. He is also the host of The Larry Kudlow Show, which broadcasts on Saturdays from 10am to 1pm ET on WABC Radio and is syndicated nationally by Cumulus Media. He is also a nationally syndicated columnist and a former Reagan economic advisor. CNBC's The Kudlow Report also airs on Sirius (ch.129) and XM (ch.127) weeknights at 7pm ET.